Can SaaS Companies Afford to Ignore Sales taxes and VAT? -
One thing I've observed while working is how common it is for SaaS and software firms to ignore transaction-related taxes (sales taxes, VAT, GST, etc. ).
And I get it.
Taxes on sales, VAT and GST are complicated, confusing and not something IT leaders would like to invest their time on.
Also, consider that delaying tax-related transactions can lead to a risk that goes beyond the payment of some back taxes at some time in the near future.
During one of my conversations with 's Global Tax Director Rachel Harding, one of the most knowledgeable people I have on the subject, she told me about:
- 40% penalties and interest She's witnessed software companies incur 40% in interest and penalties for not complying with the sales tax laws of states.
- Multi-million dollar valuation adjustments from historical sales tax noncompliance during acquisition due diligence.
and many more.
So to answer the question we asked ourselves: no, you shouldn't ignore sales, VAT, and GST taxes.
In this article in this piece, we will discuss the five main things SaaS businesses need to know regarding taxes. The majority of the information is derived from my conversations with Rachel. Below, you'll be able to stream two of our conversations to learn more.
Five Factors SaaS Companies Need to Understand Concerning Sales Taxes
1. Sales, VAT, and GST Taxes can affect SaaS Valuations
In the time that Rachel was working on a mergers and acquisitions tax team for small software companies, she saw million-dollar purchase price adjustments as a result of tax evasion.
"If you're looking to have any form of ownership change, majority or minor investment, they would like to know more about the company's operations," Rachel explained. "They will look at all your processes, like do you have a handle about where your product is tax-deductible? Are you adhering to these rules when collecting and remitting? Are you compliant? If not, they'll want you to fix it prior to purchasing itor dock the purchase price."
2. If You've Done It Correctly There's no reason to owe anything Additional
"If you do it right technically, the net zero is not a problem for you," Rachel explained.
The sales tax is a consumptive tax, a tax to the consumer and not your company. You shouldn't have to be having to pay out of pocket. It's up to you to take the sales tax on the customer's behalf -- and then pay it back to the appropriate public agency. This is a buyer's responsibility, but a seller's obligation.
"It's when you're doing it wrong that it becomes an expense and liability on your balance report. It's possible, but you're not likely to assess sales tax two years later than it's due. Then it's out of pocket."
3. Consumption Taxes Are Calculated Based on the Location that the buyer is located, Not the Seller.
Sales taxes are complicated (especially those in those in the U.S.), but generally, what you need to know is that sales tax is taken into account where the item is consumed (aka the place where your customer is located). It is not calculated based on your location or the place of your corporate headquarters.
The most relevant data used to determine the source of sales is the invoice number and the IP address of the computer. As the name implies, SaaS is taxed the same way as products, but not services which means that only 20 out of the 45 U.S. states with sales tax laws have tax rates that tax SaaS. Since the year 2018, if you've got sufficient taxable sales within a zone that exceeds the limit, then you're deemed to have economic nexus (a big shoutout for South Dakota v. Wayfair for the idea! ).
A threshold for sales is the amount of sales within a certain jurisdiction before you have to pay taxes. Each tax zone (whether it's a territory, state, territory, or a country-wide or a national level) offers its own method of delineating a threshold.
4. Tax Laws and Rules have Significantly changed in the last 10 Years
Sales taxes, VAT, as well as other taxes related to transactions have changed a lot during the past 10 years. Certain adjustments are more crucial than others, and they have altered the landscape entirely.
2015. EU Requires VAT Collection from Software companies that are not EU-based.
Since January 1st, 2015 on the 1st of January, 2015, the EU began requiring software sellers to collect and remit VAT based on the location of the buyer and not on the location of the business or its employees.
VAT rates are set by each country. This means that countries are responsible for keeping up with changes to these rates on a country level.
2018: U.S. Affirms That States May Collect Sales Taxes From Non-Resident Businesses
In the year 2018, The U.S. Supreme Court ruled that states are allowed to charge sales tax on purchases made by sellers outside of the state (including sellers on the internet), even if the seller does not have a physical presence in the taxing state ( South Dakota v. Wayfair, Inc.). (A.k.a. the reason we are writing this article since now nonresidents and small businesses need to understand sales tax and its application.)
Within the U.S., sales tax laws vary from state to state. Florida and California don't require the collection of sales tax on SaaS subscriptions. But New York and Pennsylvania do.
Then, in the year 2020 Massachusetts has reclassified SaaS fees in 2020 as "personal tangible property" meaning SaaS subscriptions now are subject to sales taxes within the state.
In our interview, Rachel offers other examples of tax law evolving to SaaS companies around the world:
"We see, everywhere over the globe, governments making rules specifically targeting non-resident businesses providing digital goods and services. There are some that have a limit of sales, some of them say every dollar counts as tax-deductible."
5. Global Consumption Taxes Are Getting More Complex
Tax laws are currently in the process of being enacted that directly affect SaaS. In the near future, in various all over the world, SaaS companies running digital platforms could have to declare every seller that uses their platform.
What is the reason tax laws are becoming more complicated?
The world is aware that they're losing the tax revenues from digital sales that software companies don't disclose.
As a result, they're finding new ways to monitor the movement of cash within their state or nation and to enforce the collections.
The 4 Ways SaaS Companies Can Manage Sales VAT and taxes
Then how can SaaS businesses determine all the tax they have to pay and withhold around the world?
There are four approaches that we observe SaaS companies employ to satisfy their tax obligations related to transactions:
1. Do not ignore It
We've discussed in this post, not paying sales tax is a popular practice -- but one that can leave your company with decades of unpaid taxes or fees and penalties. The days where this approach could be effective is waning. As online commerce continues to expand, so does the drive and ability to regulate it.
2. They'll do it themselves
Doing taxes on your own is a good option for larger companies with the resources to manage it effectively with an in-house team.
However, it's not as simple as plugging an automated tax tool into the sales system you use.
SaaS firms also must be thinking about:
- Make sure that your data is safe and easily accessible.
- Learning about what's tax-deductible and what rate to pay.
- Monitor tax thresholds so you know where you'll need to remit taxes and submit tax returns.
- Paying the right amount and submitting returns by the deadline for all tax jurisdictions where you are required to. This could be for a month, quarterly, or annually.
- Be aware of changes in tax laws and regulations.
- Answering inquiries and notices from Tax authorities. Are they phishing, or can it be taken action?
This can be burdensome to a department that does not have the technical know-how and can lead to resentment and turnover.
3. Hire an Accounting Firm
If you contract out your tax preparation, there are fewer internal resources needed and it's likely to increase the cost. And rather than a customized strategy, hiring an accounting company usually implies that they'll adopt a cautious approach with maximum compliance -- even if you would prefer something more customized.
It's an insight that only an inside tax professional can provide -- one that requires understanding the business, its strategies, tax legislation, and how they intersect.
4. Use a Merchant of Record (MoR) and Outsource the Liability
At , we act as the merchant of record for every transaction on your website, making us responsible for collecting taxes and remitting them for you. It doesn't matter if you're trying to deal with reduced tax rates, customized taxation, tax-exempt transactions B2C or B2B , all of it is taken care of for you.
A merchant of record is there to assist you if any tax audits or inquiries arise. In the event of an audit then we step in and take the lead -- so you can stay focused on building and growing your SaaS company.
What's the Best Solution for Your Company?
Maybe this is all over the top, but the best thing you can do is not to take action.
In the words of Rachel said, "I can never promise that you will or won't get audited. The only thing do I can assure you is that the smallest steps now could set you up for a more brighter and better future."
In order to determine what is the best option for your business it is recommended to evaluate your capabilities and choices.
"It's essential to know your company's needs, your footprint, global tax law (duh) as well as the risks you're willing be willing to take."
Watch My Full Interviews with Rachel Harding
Part One: The Reasons SaaS Companies Can't Afford to Ignore Sales Taxes
Part 2: How are the stricter Tax Laws Mean for SaaS
